Since the 2008 global financial crisis a significantly greater focus of attention has fallen on executive remuneration. This is particularly notable in the UK and United States. The central concerns are the reference points for setting remuneration and how decisions are made to set them.
Any discussion of the transparency, evaluation and approval of executive remuneration must be distinguished from the question of whether executive remuneration should be linked to corporate performance. Whereas the former is firmly within the scope of this study's approach to the mechanisms of «good CG» (as discussed in Section 2 «Methodology»), the latter is essentially value-laden as it makes certain assumptions about the effect of establishing such a link - as such, for the purposes of this study it is regarded as a subset of the former concerns.
In common with the approach advocated in many markets, Hong Kong has adopted a regulatory policy, set out in the HK CG Code, that an executive director's remuneration should be linked to corporate and individual performance. While establishing the link may appear to make sense in spirit, it has nevertheless been subject to abuse, particularly in the United States, much less so in Hong Kong and the other jurisdictions studied. In some instances, the link has led (possibly quite predictably) to unintended consequences, namely, short-termism and unwarranted risk taking. This has been exacerbated by changes to board composition in the form of activist directors, and changes in shareholder composition including the formation of temporary majorities being formed through «wolf packs». There are clear instances where activist shareholders have driven executive remuneration structures toward short-term growth and management reward objectives without regard to longer-term strategies or benefits to the company and its shareholders. This has particularly been the case with hedge fund investors that stand to gain from share price fluctuations over the short term. The problem is not limited to hedge fund managers - executives have also observed the opportunity to make personal gains from share price performance irrespective of whether it is in the long term interests of the company, for example, via excessive risk taking (as seen in the global financial crisis) or, in extreme cases, committing fraud (as in Enron). Where remuneration is linked to corporate performance, there must be separate safeguards as regards the decision to establish a link, and if so, vetting the nature of the link and submitting it to shareholder approval.
The wider question for present purposes is what measures are appropriate to deal with the risk of remuneration-abuse (whether or not it is linked to corporate performance). As discussed in Section 3.6.4 «Appointment of independent directors», the increased representation of independent directors has not alleviated the problem, possibly with the exception of Singapore where other factors are at play (see below). Instead, there has been a general drive internationally to give shareholders more say on executive remuneration and to improve the functioning of the remuneration committee. Proposals to impose «clawback» rights on executive remuneration have been mixed.
In the UK, the FRC has been active in introducing new provisions to the UK CG Code, including provisions dealing with the design of performance related remuneration (2008), remuneration (2010) and policies to defer, recover, or withhold variable pay (2014), as discussed in Appendix II.4.1.
The FCA's DTR mandates disclosure of the composition and operation of the issuer's administrative, management and supervisory bodies and their committees, and this will encompass the remuneration committee where one has been established. A description of the work of the remuneration committee is also required under the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2013, although this is applicable only to UK incorporated companies. This requirement is supplemented by provisions of the UK CG Code that specify the remuneration committee should be comprised of at least three independent non-executive directors, and that its terms of reference, including its role and the authority delegated to it by the board, should be disclosed. FTSE350 issuers should establish their remuneration committee with delegated responsibility for setting remuneration for all executive directors and the chairman, including pension rights and any compensation payments. Many FTSE350 companies have taken up suggestions of the FRC to implement clawback arrangements on executive pay. The UK CG Code also provides that shareholders should be «invited» to approve all new long-term incentive schemes (as defined in the listing rules) and significant changes to existing schemes, save in the circumstances permitted by the listing rules.
The link between remuneration and corporate performance and the attendant safeguards against abuse was an important focus of the Dodd-Frank reforms. The Dodd-Frank Act mandated three different types of non-binding shareholder votes on compensation matters that encompass enhanced compensation structure reporting and shareholder voting on executive compensation (see Appendix III.3.1). Although the votes are nonВ¬binding due to the primacy of directors under State laws to determine the company's affairs, it does serve as an important barometer of shareholder views of a company's compensation practices. In consequence, directors do tend to be quite focused on receiving a favorable outcome as poor results have the potential to trigger significant investor pressure and possibly litigation. Dodd-Frank also required the SEC to implement rules for compensation committee independence, and many of these have been implemented by way of mandatory requirements being incorporated into the listing rules of the Exchanges that will need to be reported on under Item 407 of Regulation S-K, which brings the disclosure within the reach of Federal securities laws (see Section 3.3.1 «Legal status of CG disclosures»).
The SEC has proposed rules, also pursuant to Dodd-Frank, directing the Exchanges to establish listing standards requiring companies to adopt policies to recover or claw back executive incentive-based compensation (i.e. tied to accounting-related metrics, stock price, or total shareholder returns) that were awarded erroneously. However, the draft implementing rules proposed by the SEC have not yet been finalized as this has been a more controversial issue and remains in a state of uncertainty following the most recent change of government, which is seeking to roll back some of the Dodd-Frank reforms.
While the SEC has also sought to implement proxy rules to bring greater power to longВ¬term shareholders, this has been successfully challenged in court, as discussed in Section 3.4.2 «Shareholder votes» above.
Notwithstanding the foregoing efforts to develop safeguards on executive remuneration, it has been observed that clawback provisions or say on pay are not particularly effective and have little effect on reducing CEO compensation levels in the United States. What appears to be essential for it to work, and which appears to be lacking, is consensus:
«In order to determine the effectiveness of say-on-pay, there must be some consensus on the nature of the problem and the desired outcome. There also has to be some consensus on what led to say-on-pay. Moreover, say-on-pay cannot be understood in a vacuum. Instead, it must be analyzed as a part of corporate governance. As long as the corporate governance system as a whole does not serve shareholders' interests properly, there is little that say-on-pay can achieve... Without the threat of say-on-pay, excess executive compensation might have been even higher, but that is impossible to measure.»
This reflects a position arrived at in other parts of this study that specific CG mechanisms intended to operate as safeguards can only be assessed and implemented having regard to all other surrounding mechanisms that provide, or fail to provide, appropriate support for a proposed CG mechanism.
In Singapore, there are also requirements for remuneration practices and disclosures (see Appendices V.1.3, V.4.1, V.7.3) although a review by the SGX reveals that remuneration matters receive the lowest score (see Appendix V.1.3). The idea is that with independent directors as members, executive directors would not get to set their pay, and abuse can be avoided. The Remuneration Committee's responsibilities are to review and recommend to the Board a general framework of remuneration for the Board and key management personnel and review and recommend to the Board the specific remuneration packages for each director as well as for the key management personnel. While excessive executive compensation continues to be an issue in the United States and UK, raising the question whether the remuneration committee is an effective mechanism, this does not appear to be a problem in Singapore - although possible exceptions could be Mainland China state-owned enterprises (S-Chips) which are not well-monitored by State-owned Assets Supervision and Administration Commission of the State Council (there have been some instances of abuse taking various forms with S- Chips (see Appendices V.1.4 and V.7.3) or private firms where the controlling shareholders are also the executive directors. However, it is likely that with GLCs being majority-owned by the Singapore government, and other private firms owned by controlling shareholders, there is informal - and arguably effective - control on executive compensation imposed by the government or the controlling shareholders. What may be of relevance to note in this regard is that INEDs are much better paid in Singapore than their counterparts in Hong Kong (see Appendix V.1.3). Whether this signals that INEDs have a greater influence or whether this is merely part of the consensus package that comes with government and controlling shareholder influence is open to debate.
In Mainland China, as in Singapore, executive remuneration does not appear to be an issue as it is frequently subject to close monitoring and control by the State as the controlling shareholder. However, following Western concepts, Mainland China employs a committee - the remuneration and appraisal committee - with similar functions to its counterparts elsewhere, including a requirement for disclosure of information concerning remuneration policy and director remuneration (see Appendix IV.7.3). Pay for independent directors, as in Hong Kong, is also on the low side.
Hong Kong
The focus in Hong Kong is primarily concerned with the formation and functioning of the remuneration committee under the HK CG Code. As indicated in the comparison Table of the UK and HK CG codes in Annex 1 to Appendix I.4, the arrangements in both Hong Kong and the UK cover similar principles regarding the level and make-up of remuneration and disclosure. For example, both codes require the remuneration committee to consider salaries paid by comparable companies.
A notable difference is that whereas the UK CG Code provides that the remuneration should have delegated responsibility for setting remuneration the HK CG Code only requires disclosure of whether the remuneration committee determines remuneration with delegated responsibility or merely makes recommendations to the board. The UK CG Code also provides considerably greater detail, and emphasis, on the provisions the remuneration committee should follow when designing performance-related remuneration for executive directors, which in Hong Kong receives only a brief mention as a recommended best practice. Unlike the UK CG Code, the basis on which INEDs should be remunerated is not addressed by the HK CG Code. Taken together, the HK CG Code in its provisions represents a relatively diluted detailing of the principle that issuers should disclose their remuneration policy and other remuneration related matters, the latter of which is potentially quite encompassing.
As regards developing shareholder voting on executive pay, there appears to be relatively little momentum in Hong Kong on the issue, or for imposing clawback mechanisms. At the present point in time, that may be appropriate given the issues encountered in the other jurisdictions studied.
Discussion
Executive compensation has been most widely discussed in the United States and the UK, with no definitive solutions. In the UK, the Government has been trying to solve the problem for more than 25 years, first through the CG Code as a result of the Report of the Greenbury Committee in 1995, without noticeable impact. Critics have doubted whether it is any more likely to be successful in the current environment.
The difficulties encountered in the jurisdictions studied, the absence of a clear mandate from the market that executive compensation needs to be better regulated and the different context of Hong Kong suggests that it may not be appropriate at present to develop a mandatory regime for shareholder votes on executive pay or clawback mechanisms. Similarly, there seems little momentum to mandate a greater involvement of INEDs, first because of the weak effectiveness of doing so elsewhere (see above and Section 3.6.4 «Appointment of independent directors»), and second because in Hong Kong this appears to cut too deeply into the mandate of the board to determine such matters as it considers commercially desirable. Even if some form of regulations were introduced, a necessary consensus to make them effective may not form - in which case the regulations run the risk of serving to validate remuneration without actually influencing it. The Hong Kong context may therefore be better served by leaving remuneration as a commercial matter to be decided by the board and assessed by shareholders upon receiving adequate disclosure. That implies shareholders need to be able to vote a director out if, for example, they feel the performance of the director is not commensurate with the remuneration received. As discussed in Section 3.4.2 «Shareholder votes» and more particularly in Section 3.7.7 «Differentiation of CG requirements», there may be some value in discussing further the frequency with which shareholders are able to exercise this right. The discussion on board refreshment also supports such an approach (see Section 3.6.3 «Board refreshment»).
The foregoing does leave open the question of how to foster adequate disclosure to shareholders as regards remuneration and its determination. The UK, via the UK CG Code, sets out the provisions the remuneration committee should follow when designing performance-related executive remuneration, whereas in Hong Kong this receives only a brief mention as a recommended best practice. The United States, via Exchange rules, requires the independence of the compensation committee to be reported on in a manner that brings the disclosure within the reach of Federal securities laws - in Hong Kong while the terms of reference of the remuneration committee and whether or not it comprises INEDs is required to be disclosed, this has limited consequences if it amounts to a mis-disclosure. If the functions of the remuneration committee are subject to higher disclosure standards, this will improve transparency of executive remuneration to shareholders and accordingly their opportunity for exercising meaningful involvement. For the above reasons, there is some justification for better disclosure of performance- linked remuneration.
The foregoing leads to Recommendation A4.1.2 «Transparency of performance related executive remuneration».
As the above recommendation provides for mandated disclosure, it should be read together with the recommendations that would attach legal consequences to misВ¬disclosure or failure to disclose: Recommendation A4.5.1 «Legal status of CG-related disclosures», Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)» and Recommendation S4.3.2 «Disclosure of non-compliance with issuer's disclosed CG practices».
As regards the remuneration of INEDs, there is a plausible case for suggesting that the basis on which INEDs are remunerated should be given further consideration. Almost all of the interviewees expressed concern that many INEDs of listed issuers in Hong Kong do not fully appreciate their role on the board and take up INED roles as trophy posts without regard to their responsibilities or their liabilities. A number of interviewees expressed the concern that if an INED is being paid a token fee what message does this send to them in terms of their responsibilities and liabilities? It is probable that they are not expected to do very much save as is sufficient to ensure the INED requirements are met on a box-tick basis.
In the UK, it is recognized that the remuneration for non-executive directors should reflect their expected commitment and responsibilities, and that this should in general not include performance-linked remuneration. As already noted above, the HK CG Code provides very little detailing on the requirement to disclose remuneration related matters - on the topic of the remuneration of non-executive directors, it only provides that the remuneration committee's terms of reference should include making recommendations to the board.
The foregoing leads to Recommendation A4.2.2 «Basis of INED remuneration».
The role of remuneration in the overall matrix affecting an INED's performance is further discussed in Section 3.7.10 «Requirements relating to INED performance», which also discusses the other findings of this study as regards the requirements that should be imposed in relation to INEDs.